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Personal finance: Security is what we want

Lenders have to face reality and start offering home loans at a decent cost to suit customers; It is not the cost of a house, but the cost of the finance that should top the agenda
It may be just a straw in the wind, but with any luck this week's hint from Northern Rock that it is considering changing the way it funds its mortgage lending will prove to be an important (and overdue) watershed in the cost of owning a home in this country.

The building society (soon to convert to a bank) says that it is looking at ways to fund its lending to home owners by issuing securities to investors, rather than relying on the traditional building society source, which is the deposit accounts of its savers. The technique of funding loans with securities backed by a lender's mortgage book is widespread in the United States, but has been slow to reach this country, despite many predictions that it was on the way.

The argument for switching to mortgage-backed securities as a source of finance is that it should enable lenders such as Northern Rock to borrow money for home loans more cheaply than they can raise money at the moment. This in turn will allow them to compete more effectively, either by taking market share from other lenders with more expensive sources of finance, or by increasing their profit margins on home loans.

The immediate trigger for Northern Rock's move, apart from its impending demutualisation, seems to be the entry of new competitors in the market for retail savings. Companies such the Prudential with its EGG account, and Standard Life, are offering higher rates on savings accounts than the banks or building societies reckon they can afford.

If this turns out to be the start of a trend, which is not unlikely, it can only be good news for borrowers. The sad truth is that, while we in Britain spend an inordinate amount of time fretting over which type of mortgage to have, and what is happening to house prices, we tend to lose sight of the fact that the real problem we face in a low inflation environment is how expensive and inflexible our mortgage finance is.

Compared to other countries in Europe, which have long enjoyed low-cost, long-term, fixed-rate mortgages, and the US, where securitisation of home loans is widespread, the price we pay for our home loans remains, in general, extravagantly high, and the system by which we obtain them excessively inflexible.

When you consider that inflation is now firmly entrenched at around 2 per cent per annum, the fact that many home owners are still paying 8 per cent or so for their mortgages is little short of extraordinary. A real (inflation-adjusted) rate of interest of 6 per cent is very high for long-term lending which is fully secured on property values (and that's before the fact that many lenders require you to pay the cost of insuring that such security might not be enough!).

In fact, the business of mortgage lending in this country has been so profitable for most of the last 15 years, that it is no surprise that new lenders keep falling over themselves to try and get into the market. It is true that increased competition is belatedly having some impact on the cost of home loans, as anyone who has enjoyed a cashback or cut price mortgage offer in the last three years will testify.

For the first time in many years, canny buyers and homeowners who switch their lenders have recently had the chance to enjoy some terrific mortgage bargains. But because existing borrowers seem content to cross-subsidise the new business their lender is wooing with its cut-price offers, overall profit margins in the business still remain high.

It seems that most existing borrowers are either too lazy, or perhaps too diffident, to work out that they should be able to take advantage of these new market conditions to strike a better deal for themselves. Anyone who opted for a fixed rate mortgage is discovering that they are paying a high premium for the insurance of knowing their repayment obligations in advance. Needless to say, the lenders are doing all they can to lock in those who take advantage of new cheap deals with hefty redemption penalties and similar loyalty devices.

In the days when house prices were soaring, and the government dispensed hefty tax breaks for house purchase, the need to worry about the cost of a mortgage was limited. But now that world has gone, and the scope for consumers to exercise their muscle is much increased. But they still seem reluctant to take full advantage of the opportunity. It is not the cost of a house, but the cost of the finance, which should top consumers' agendas.

Given the other strange things that have gone on in the mortgage market over the years (including the remarkable resilience of the commission- led endowment mortgage), it is small wonder perhaps that the banks and building societies have struggled so hard to avoid regulation of the mortgage market. It must be open to doubt whether the new voluntary mortgage code will head off some degree of regulation by government (an outcome to be avoided if at all possible).

My hope, as I said the other week, is that consumer pressure is finally starting to assert itself, and will eventually do the job before heavy handed government regulators get involved. Securitising mortgage loans, if it now happens, would certainly be another welcome step down the path towards a healthy competitive market in mortgages. It suggests that lenders are finally being forced to accept the new reality and do all they can to cut their funding costs.

Theory suggests that a big mortgage lender with access to securitised finance could cut the margin on mortgage lending to 1 per cent or less. This compares with the 1.4 per cent typically required by banks funding their loans in the money markets, and the 2 per cent which lenders traditionally charge for the privilege of helping us buy our homes. Securitisation works in the United States, and if it doesn't come to this country soon, we really should start asking ourselves why.